Climate Risk and the Price of Audit Services: The Case of Drought

Abstract

SUMMARY This study examines the impact of drought on the pricing of audit services for U.S. firms over the period 2001–2015. We employ the Palmer Drought Severity Index (PDSI) to determine drought intensity conditions at the state level on a yearly basis and regress audit fees on drought intensity after controlling for other known factors of audit fees. We document that auditors charge significantly higher audit fees for client firms headquartered in areas affected by drought. The effect of drought on audit fees is more pronounced among firms with lower accruals quality and among firms with high business operation concentration in their headquarter states. Collectively, our findings suggest that climate risk in the form of drought not only affects firm risk but also audit risk, thereby highlighting that externalities from climatic conditions are relevant to firms and auditors.